Being right isn’t good enough

By Bengt Saelensminde Mar 13, 2013

Bengt Saelensminde

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It’s been said that the four most dangerous words in investing are “this time it’s different”. But I think the opposite is every bit as dangerous: “things will have to revert to the norm”...

The thought struck me as I read a response to Monday’s Right Side. On Monday, I laid out ten reasons why the Footsie is doggedly pursuing its northward march. One reader reasoned that the main stimulus seems to be coming directly from the planners, and when that goes, so goes the fundamental support for stocks.

“Interest rates have to rise sometime!”

Aaah, that old chestnut. Things have got to revert to the norm... The key question is, when?

Do you short the market? Do you just sit it out? How much will you make if you’re right? How much will you lose if you’re wrong?

Fortune favours the bold... nah!

I’m not convinced by everything JM Keynes put down on paper. But I’m pretty certain his maxim “markets can remain irrational longer than you can remain solvent” is bang on the money.

The fact is, being right isn’t actually that useful. Not if you’ve got your timing wrong! Things may well change, but not before you’ve lost a ton of money and end up looking the fool.

Here’s a chart of the FTSE 100 over the last 15 years. I want to use it to explain exactly what I mean...

FTSE 100 chart

Source: Digitallook.com

There are two very visible peaks. First, the dotcom-induced millennium push, then the '00s peak; itself brought about by the intervention of the central planners in trying to fix the dotcom bust. That was the planners' trial run in fixing equity markets.

Of course today, we see the real thing. The third peak is in progress right now... the result of the planners’ unprecedented stimulus.

The point is, just look at how long these rises and falls take to play out. Do you really say “hey, this market is plain wrong – I’m sitting this one out!”

During the '90s, a great fund manager did exactly that. Tony Dye, who became known as 'Dr Doom', was convinced the markets were getting way ahead of themselves. He took the bold action of removing client funds from the market.

Of course, he was right... in the end. But his timing was spectacularly wrong. He lost his job, his reputation and undoubtedly, a lot of client money.

During the dotcom bubble, even the judgement of the great Warren Buffett was called into question as he doggedly stuck to his guns and sat out the technology stock frenzy. For sure, he was right in the end, but I tell you, those years of underperforming the markets led many to question whether the old sage had lost it.

And then, it was the '00s run-up. How many sat out the great bull run that practically doubled the value of the market?

I mean, these upswings take years to play out.

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Can you take that much pain?

Taking bold steps can be traumatising. Being right can be deeply unpleasant when the market keeps plodding on without you.

And of course, you have to consider that the naysayers could be wrong. What if the central planners can keep meddling, keeping interest rates down and liquidity up? What if the assumption that “things have revert to the norm” is plain wrong?

For heaven’s sake, interest rates have been held in check for over four years now. Who’s to say the policy won’t go on for another five or ten years?

Do you have what it takes to sit this out? Do you really want to ‘fight the Fed’?

Some investors are shorting this market upswing. Well, maybe they’re right.... but I tell you, being wrong could be very costly. The 2003 market upswing took five years to play out. Today, we’re four years into the upswing. Will this one last the same amount of time? Will it go on for longer?

Who knows?!

All I know is that getting on the wrong side of the move can be horrible. “Things must change... rates must rise... the liquidity bubble must pop... stocks must fall” is all well and good; but do you have the tenacity to sit out another year, two or even five years of bull market action?

How to play it

The truth is, I’ve been sceptical about this market upswing for quite a while. So the way I chose to play it was by being underweight equities - I didn’t dump stocks, I just trimmed them back. To my mind, sitting out wasn’t an option. I am no Dr Doom!

And seeing the tenacity of the central planners, recently I even upped my equity weighting.

I’m not saying you should do the same. I just urge you to reflect on how long markets can move in the ‘wrong’ direction. Diversification is the key to playing the investment game... and not making rash moves.

For instance, by putting some money into emerging-market equities, I’ve been able to insure myself against the weak pound at the same time as I up the equity stakes. Investing far away means you need good information, of course… but that’s where Lars Henriksson comes in. He’s reliable. Click here for more from Lars.

They say that fortune favours the bold. Hmm... the bold also have a habit of dying young. I am not trying to push readers one way or the other. I just think it’s worth considering the fact that getting back to normal could take years – and that’s a long time to be right wrong!

• This article is taken from the free investment email The Right side. Sign up to The Right Side here.

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Published in Investment strategies | More articles by Bengt Saelensminde

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  • 1. Bill D

    (13 March 2013, 06:19PM)  Complain about this comment

    All of you commentators are too young. Dont forget "events, dear boy, events" and the good old Sterling crisis. The point is, as you say, you need to be right and astute. The truth is the longer you remain right the riskier it is to do nothing about it. Try hitting the top or bottom, I never have.

  • 2. 4caster

    (13 March 2013, 07:05PM)  Complain about this comment

    In 2003 I found a long-term way to short the market, through two bear funds, Gartmore Govett UK equity bear fund and Gartmore Govett US Bear Fund. Faithfully they tracked the inverses of the FT-SE 100 index and the S&P500 whilst those indices recovered and doubled. By November 2007, just as the equity markets peaked, Gartmore Govett announced that they were discontinuing those funds two months later, on the grounds that "investments" in them had dwindled to a few million pounds. I likened that to M&G famously discontinuing their Gold&General fund at Brown's Bottom in 1999.
    Then in December 2007 markets started to crash, and at least I had the satisfaction of a 20% uplift between the announcement and the enforced payout. But I have never found another long term bear fund that will faithfully track the inverse of anything.

  • 3. simon

    (13 March 2013, 09:08PM)  Complain about this comment

    I'd like to know what those brave souls who re-entered the markets around March 2009 and who presumably rode it up with a few downward blips until now and as a result have done extremely well - Are theybuying or thinking about selling ?

  • 4. Boris MacDonut

    (13 March 2013, 10:36PM)  Complain about this comment

    Bengt your chart of the last 15 years covers 18 years. But you are correct to doubt that there is any such thing as a norm. My car often travels at 10mph and often at 45mph and I have even hit 95mph (with due car and attention). Sometimes i am stationary or even in reverse. The average mph counter tells me I do 27 mph as the norm.

  • 5. Changing Man

    (14 March 2013, 11:41AM)  Complain about this comment

    Re:3 I am one of those "brave souls" as you say who weathered the downturn and came up the other side! Looking at the charts it suggests that its time to get out and I'm reminded of Baron Rothschild who claimed he made his fortune by selling too soon! Even though I am sitting on some decent gains I am inclined to wait until there is an alternative defensive home for my investments. I don't believe it's gilts or corporate bonds and I honestly believe that gold is in the "capitulation" phase of a classic bubble curve in spite of whatever MW's "resident gold expert" forecasts. I will gradually move into cash and sit out the next downswing. Annoyingly I will have to pour more money into my gold shares before making any kind of graceful exit. Ironically I am currently sitting on losses up to 50% due to my weakness in listening to poor market timed tips from MW!

  • 6. Ann

    (14 March 2013, 11:49AM)  Complain about this comment

    I upped my equities when you did. I am glad.

  • 7. Clive

    (14 March 2013, 01:28PM)  Complain about this comment

    As Bengt says "just look at how long these rises and falls take to play out".

    Hence no need to rush out of a currently rising market. History says we'll have 2-3 years on the next big downslide.

  • 8. vic silk

    (14 March 2013, 03:30PM)  Complain about this comment

    In 1987 I sold out in July and missed the last 10% of the rise. It does not profit to act too soon.

  • 9. Tom

    (14 March 2013, 05:06PM)  Complain about this comment

    "just look how long these rises and falls take to play out"

    From early September to mid October 2008 30% was wiped off the value of the FTSE 100.

    Not long at all really................

  • 10. Clive

    (14 March 2013, 05:57PM)  Complain about this comment

    Tom

    Agreed on the drop, but it was back to the same level by end of 2009. OK, 16 months with no growth is no fun, but plenty of time to book capital gain losses (great idea !) and to put money in at cheaper prices.

    I stayed fully invested the whole time and don't really regret it.

  • 11. Impromptu

    (14 March 2013, 06:30PM)  Complain about this comment

    simon:
    I went in in 09, again in 10, largely out in July 11 and straight back in during August. I deal very occasionally - only twice last year. I've been motivated by the notion of frightened money in bonds for at least two years - clever me.

    I'd love to claim some market timing gene, but while I've had my ongoing concerns about markets, the first move was occasioned by an inheritance and the third move by my patience finally snapping over paying through the nose for fund underperformance. So it's mainly been luck tbh.

    Currently I'm about 65% mostly defensive income equity, 15% high-yield and EM fixed income and 20% raw cash. FTSE100 internationalisation aside, something like 15% of my income stream is in dollars.

    My first priority is to put a large ISA cash balance to work, but I've a feeling the effect of this season's window dressing has been underestimated by many. So I'm holding off for now.

  • 12. Colin Selig-Smith

    (14 March 2013, 09:04PM)  Complain about this comment

    I'm (mostly) out of US & UK equity markets by now. They're simply not cheap, it really doesn't matter if they continue going up 15% or 20% for another year, in two years they'll start falling, though I suspect much earlier given the margin debt.

    I'm looking for cheap stuff elsewhere I can leave it for five or ten years and make N00% gains.. Russia, Ireland, Greece, Africa etc.

  • 13. Colin Selig-Smith

    (14 March 2013, 09:06PM)  Complain about this comment

    Of course there's another more important point. If you look at the FTSE in terms of gold/corn/soya, it isn't nearly as rosy as it appears using GBP.

  • 14. Ron Fibonacci

    (15 March 2013, 08:57AM)  Complain about this comment

    In a rising market, the consequences of any downside movement can be partially alleviated through the use of stop losses. Ride the market higher but have a safety net in place. Whether you go for a 3% or 15% stop loss will depend on the share of course. Hargreaves don't allow stop losses for shares outside of the FTSE 350 in the UK so you do have to be very careful with AIM shares. If I had used stop losses in my first 2 years as a novice investor I would have saved several thousand pounds.

  • 15. clarinetplayer

    (15 March 2013, 03:45PM)  Complain about this comment

    A well-written, thoughtful piece. Really enjoyed reading it, Bengt.

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